Viral Acharya says equity markets look too frothy, buoyant compared to ground realities

Ordinarily an event of this magnitude would be accompanied by a fair degree of volatility in global financial markets, particularly those in developing economies.

One just has to look at the damage wreaked in 2013 by the mere mention of the word ‘taper’ by then US Fed Chairman Ben Bernanke. Bernanke’s statement, which was referring to Fed’s eventual plan to taper bond purchases undertaken since the global financial crisis, caused a financial tantrum worldwide, with currencies such as India’s marking fresh record lows in the space of just a few days.

Cut to November, 2021. Global markets all but shrugged off the Fed’s plan to reduce monthly bond purchases by $15 billion per month. US equity markets rose while the upswing in bond yields was not of an alarming magnitude.

Dr Viral Acharya, former Deputy Governor of the Reserve Bank of India succinctly explains why the situation is this time around.

“Coming to the broader question of what impact the Fed normalisation will have, I think the biggest elephant in the room is how much froth there is in the markets all over the world. This relates to the stock market in particular but to an extent it also relates to the bond markets,” Acharya said in an exlusive interview with ETMarkets.com.

“And in a way if this is the expectation of the market – that the central bank will not unwind its policies; or even if it wants, to will not find it easy to unwind its policies, then in some sense there is an explicit liquidity guarantee that is being built into the prices,” he said.

Acharya, who was the Deputy Governor in charge of monetary policy at the Indian central bank from 2017 to 2019, believes that there is some divergence between the performance of stock markets and the real economic performance on the ground.

“…in my view, the equity markets look too frothy, too buoyant compared to the ground realities. If you just look at the three-day equity market run pre-Dussehra from 18,000 to 18,500 on the Nifty index. Globally the news was bad on the energy sector all over and yet the Indian markets were just on a tear,” the former central banker said.

“I have no way to make sense of this other than that it is just a technical-flow-driven run up”.

In September, the BSE Sensex crossed the historical 60,000 milestone, with the central bank itself saying that the Indian equity market had risen to become the 6
^th most valuable in the world with a 3 per cent share in global market capitalisation.

Liquidity in India’s banking system has been maintained at a huge surplus for more than two years now, with the cash surfeit being amplified since the onset of the coronavirus pandemic. The RBI has been keeping liquidity at a large surplus in order to ensure low borrowing costs in the economy amid the shock inflicted by the COVID crisis.

Acharya, who currently is the C.V. Starr Professor of Economics in the Department of Finance at New York University Stern School of Business, pointed out that real rates in India were extremely negative and that deposits and fixed income instruments were not earning much.

“Bankers and mutual fund managers are probably calling household; every single day telling them to move their money into equity and other kinds of SIPs. So I think we have to be careful in my view,” he said.